Week 4 Flashcards
What is NWC?
Difference between CA and CL
What is the firm’s insolvency risk?
The probability that a firm will be able to pay bills as they come due
What is more profitable for most firms A or CA?
Assets
How does the risk of insolvency decrease?
By increasing the ratio of CA to A
Because CA can be converted to cash in the short term
What does the ratio of CL over total A indicate?
The % of assets that have been financed with short term liabilities.
Why does increasing CL increase profitability?
Because the firm is using less expensive financing
Why does increasing Cl increase risk?
Because more current liability results in more liabilities due within the next year.
What is the cash conversion cycle (CCC)?
The time gap between when firms pay suppliers and when they receive payment from customers.
What is the operating cycle (OC)?
Time from purchase raw materials to collection of cash from sales.
What is the average age of inventory (AAI)?
Time from materials being acquired to finished goods sold
What is the Average Collection Period (ACP)?
Time to collect Sales
What is the average payment period (APP)?
Time to pay off credit purchases
What is the permanent funding requirement?
If sales are constant, investment in the operating assets should be constant
What are the seasonal funding requirements?
When firms sales are seasonal, investment in the operating cycle will vary
There will also be a permanent funding requirement for the minimum investment in operating assets
What is an aggressive funding strategy?
Funds seasonal requirements with short term debt and permanent requirements with long term debt or equity.
Why is the aggressive funding strategy riskier?
Because of interest rate swings and possible difficulties in obtaining needed short term financing
What is the conservative funding strategy?
Both seasonal and permanent requirements financed long term debt or equity.
Long term debt is more costly
and always pays interest even when not using financing
How can managers maximize shareholders’ wealth in consideration of the CCC?
- Minimize the length of the CCC
- Turnover inventory quickly, No stockouts
- Collect AR quickly, Without being too stringent
- Pay AP slowly, without damaging credit
What is the ABC inventory System?
Group A
- Most intense monitoring because of high dollar investment
Group B
- Controlled through periodic checking
Group C
- Unsophisticated, 2 Bin method, reorder inventory when 1 bin of 2 empty.
What is the economic order Quantity?
The trade-off between order costs and carrying costs
What are order costs?
Fixed costs of placing and receiving an order
What are carrying costs?
Variable costs per unit of holding an item
- Increases as order size increases
What are the EOQ Variables?
S = Usage in Units O = Cost per order Q = Order Quantity C = Carrying costs
What is lead time?
The time it takes to manufacture.
The time it takes to ship and pack the product or both
